Indian Aviation Industry’s Profitability At Risk, Pricing Holds The Key
Airline that ‘refuse to sell below cost will survive the storm’.
A year after posting first profits in a decade, India’s aviation industry is expected to slip back into the red in the ongoing and the next fiscal.
Limited ability to hike fares, rising crude oil prices and aggressive borrowing plans to buy planes may eat into the profitability of Indian carriers in the financial years (FY) 2016-17 and 2017-18, a report by aviation adviser and researcher CAPA India said.
IndiGo, Jet Airways, SpiceJet, GoAir and Air India Express are expected to remain profitable in FY17, but at a level lower than in FY16. Losses will increase at Air India, AirAsia India and Vistara, which is expected to pull the industry into the red with combined losses of $250-300 million, CAPA said.
The industry’s losses could widen to $380-450 million in FY18 with fuel prices estimated to be around $55-60 a barrel and exchange rate in range of Rs 73-75 a dollar, the report said.
Helped by lower fuel prices, modest capacity and a strengthening economy, listed players like SpiceJet Ltd., Jet Airways (India) Ltd. and InterGlobe Aviation Ltd. (IndiGo), which went public in November 2015, had reported profits on the back of surging traffic growth in FY16.
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India’s airlines reported a combined profit of $122 million in FY16, the first time in a decade. This era of industry profitability is likely to be short-lived... Traffic growth is being stimulated above its underlying demand as a result of excess capacity and competitive fares...At a total industry level, losses could reach $250-300 million (in FY17).CAPA Report
Aggressive Capacity Expansion
Indian carriers have ordered 880 aircraft, of which 600-650 are expected to be delivered over the next 10 years. Financing these orders, which have an estimated value of $30 billion, may become challenging, according CAPA India’s outlook for financial year 2017-18.
The industry is scheduled to induct 60-65 narrow-body planes and 10-12 small aircraft in FY18, according to CAPA estimates.
The airlines are expected to raise close to $1 billion in FY18, led by Jet Airways at $300-400 million. Any delay in raising funds may cost Indian carriers and market conditions are “expected to turn” in the near term, the report said.
Crude Oil Prices Rising Again
Fuel expenses are a substantial part of an airline’s operating costs. The sharp fall in global crude oil prices had resulted in steep cuts in airfares in FY16.
Crude prices have started rising again, helped by production cuts since January by Organization of the Petroleum Exporting Countries (OPEC), led by Saudi Arabia. U.S. crude, or the generic WTI benchmark, has risen to $55 a barrel in February 2017 from below $30 a year ago.
There is uncertainty on where the fuel prices are headed. It largely depends on whether the OPEC bloc continues to cut production to boost prices.
“We are going to go for much higher levels of compliance because of the very high level of stocks that we have brought over with us from 2016,” OPEC secretary-general Mohammad Barkindo said in a Bloomberg television interview in London. “Anything less than 100 percent is not satisfactory” and OPEC expects to achieve that level “in due course,” he said.
GST May Affect Air Traffic Growth
The next financial year is likely to be the third consecutive year of traffic growth, CAPA said.
Domestic air traffic has seen a steady growth since 2012-13 and rose 21.2 percent last fiscal, with the load factor hitting a record 90 percent for the year.
CAPA estimates the traffic growth to accelerate to nearly 23 percent in FY17, with India likely to taking over Japan to become the world’s largest domestic market behind the U.S. and China. Domestic traffic could grow by close to 25 percent in FY18 to approach 130 million passengers, the report said.
“Growth could have reached as high as 25 percent but may be tempered 3-5 percentage points lower because of the impact of demonetisation and the introduction of Goods and Services Tax, depending upon the tax rates applicable for air travel and inputs,” CAPA said in its forecast for 2017-18.
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Pricing Discipline Is Key
The industry has been growing at 15-20 percent range yearly but may not be able to sustain the momentum, said independent aviation analyst Captain Shakti Lumba, who has headed operations at IndiGo and Air India. With increasing crude prices, airlines may want to increase fares but the moment they do that, the passenger load would fall, he said.
In order to fill the seats, the airlines would have to slash their fares and sell below cost, which may again lead to losses for this price sensitive sector. But the only airline which can survive this storm would be the one who would refuse to sell below cost. Airlines which have lower cost structure would be able to fly through the turbulent skies.Captain Shakti Lumba, Aviation Analyst
Pricing discipline holds the key in face of aggressive capacity expansion.
Historically, the domestic airline industry has displayed poor pricing discipline, a report by brokerage IIFL Institutional Equities said. The industry has shown pricing discipline only during a sharp reduction in capacity like Kingfisher Airlines' troubles in FY13 and SpiceJet’s financial distress in FY15, said the report titled ‘Survival Of The Fittest’. “As soon as the supply-side issues were restored, carriers have gone back to predatory pricing to try and gain market share.”